Corporate Mergers and Acquisitions: A Guide for Practitioners and Transaction Team Members

By Michael Waks

This book is a practical guide for the successful execution of mergers and acquisitions within mid-to-large sized corporations. The key is deploying tools and processes which build trust among team members and the executive management team. The internal team is complimented by the retention of thoroughly vetted external advisors. Specific advice on how to vet and contract these advisors is detailed. By use of the tools and processes the high-performing transaction team, with members from the Corporate Development department or M&A group, as well as other professionals whose responsibilities include supporting transactions but are not dedicated full-time to M&A, will have a shared understanding of project timing, steps, and responsibilities. Detailed timelines with step-by-step activities are provided for acquisitions, divestitures, licensing, joint ventures, and integration. "Lessons Learned" are amplified through reference to the author's personal experiences spanning three decades in corporate development and strategy. Included in this guide are sample templates for planning, due diligence check lists, communications, negotiating strategy, and strategic screening which have proven useful across multiple industries. Examples of bid instructions, bid letters, confidentiality agreements, information memorandums, transition services contracts, and fairness opinions are provided to add clarity to the execution steps.

• Language: English
• Publisher: BookBaby
• Release date: Sep 17, 2018
• ISBN: 9781543948622

Book preview

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Chapter 1

Transaction Alternatives

Pre-Deal Considerations

The considerable time, resources, and expenses associated with corporate development transactions – acquisitions, divestitures, joint ventures, and licensing – makes it imperative that the Corporate Development team help senior management and the Board of Directors (the Board) thoroughly explore the pros and cons of these options before a particular path is chosen. The Chief Financial Officer, the Head of Strategy, and the Chief Legal Officer should either directly or through their representatives provide their expertise and advice at this early screening stage.

In my experience, different stakeholders inside the company will have valid reasons for and concerns with any significant transaction. Ultimately the Chairman (and depending on the materiality or importance to the company of the proposed transaction, the Board of Directors) will need to balance conflicting perspectives and decide on the best course. To illustrate the divergence in perspectives we can consider a hypothetical public company faced with a sub-scale business slowly losing market share. Senior management in the hypothetical company could easily have a range of opinions and concerns on how best to strengthen a sub-scale business:

President of the sub-scale business: She is an advocate for the acquisition of a competing business to achieve economies of scale and greater relevance with retailers. The President’s compensation may be geared to metrics such as market share or operating profit, which could influence her assessment – particularly in the absence of a charge against the business for capital invested.

Chief Financial Officer: (CFO) He may be concerned with the impact of incremental debt needed to fund the acquisition on the company’s credit rating, particularly if the possibility of acquisitions has not been featured in presentations with investors or the credit rating agencies. Further, if the acquisition is not immediately accretive to earnings per share the CFO may lose credibility with investors, as a negative impact to earnings could conflict with previous guidance.

Head of Strategy: The Senior Vice President of Strategy endorses the acquisition based on the long-term attractiveness (growth and profitability) of the category the business competes in. He believes there will be a resulting competitive advantage derived from the scale of the combined businesses to enable market share to be stabilized and possibly grow over the long term.

Chief Legal Counsel: She questions whether the business combination will pass muster with the anti-trust authorities. She is also concerned with the significant time and legal resources needed to pursue the acquisition. The alternative she advances is two-pronged: (1) looking at outsourcing production all or in part to a third party to achieve economies of scale and (2) pursuing licensing arrangements to secure an expanded range of brands to market. The Chief Legal Counsel has an annual budget for all legal matters and a complex transaction could lead to an overage.

The Corporate Development group can help illuminate the choices facing the company in consultation with internal subject matter experts, with thorough analyses including:

•The value achieved by each alternative, typically expressed as the net present value;

•The impact either positive or negative on earnings per share, including one-time impacts associated with transaction execution or integration expenses;

•Impacts on stock price, and the attractiveness of the stock to investors;

•The impact on debt covenants and the debt ratings of the transaction;

•The time, expense, and manpower resource requirements of the alternatives;

•The probability of successfully executing each transaction;

•The risks of rumors/leaks spreading and impact, if any, on the current business.

A summary of the alternatives which the executive team can use for discussion with the Chairman and could serve as the centerpiece for discussions with the Chairman and/or Board follows as a template:

The template is a starting place for an extensive, interactive discussion with the senior management team and the Chairman. Valid concerns with the availability of personnel to pursue the transaction alternatives, risks of leaks and distraction to the business, morale impacts and labor responses, and how to best manage the expectations of senior operating managers are among the soft impacts which need to be carefully weighed and managed.

The willingness (or lack thereof) of the Board to support a given strategic alternative will also factor into the discussions and may constrain the decision makers at an early stage. The Corporate Development group can look at the types of transactions Board members have undertaken in their own businesses as well as those they have supervised as part of other Boards, and whether those transactions were generally viewed as successful. If there were similar transactions the Board members were exposed to that proved to be unsuccessful, early planning on how to mitigate the relevant risks and incorporating action steps to address the issues will be both prudent and well-received.

Chapter 2

Communications

Executive Summary

Your internal officers and their senior staff responsible for managing key external constituencies and internal stakeholders will appreciate being informed of a potential transaction at the earliest possible juncture. Providing them with appropriate detail at the right time will go a long way toward building trust with this core team of experts. They maintain the firm’s good standing with regulators, lenders, shareholders, unions, and employees. The Treasurer, Controller, Head of Human Resources, Head of Investor Relations and similar senior managers will add considerable value to transaction planning when brought in early.

The opposite holds true as well. Failure to communicate with these executives and their senior staff will erode trust, and make it much more difficult to execute the transaction without stepping on a legal or regulatory landmine. The good reputation and goodwill these officers and senior staff have built over years (and sometimes decades) with their external constituencies and the Board of Directors can be damaged by a transaction which does not conform to requirements on disclosure of and timing of that disclosure. Mitigating anxiety of the senior internal staff is key.

After selection of the type of transaction to pursue, the question immediately arises which entities need to be informed as the transaction proceeds. The answer depends on a number of factors, including whether the company is publicly listed (or its debt is listed) on a securities exchange, the materiality of the potential transaction to the company, and whether contractual covenants or state regulations require disclosure. Understanding regulatory disclosure requirements for transactions involving publicly traded companies, particularly when taking place outside the United States, is particularly crucial and should be addressed with legal counsel well before an approach is made.

I recommend the constituencies identified on the following chart be consulted with as part of the communications plan prior to taking any action, and the specific timing and language be vetted in advance by legal counsel, public relations, and investor relations:

In addition to required disclosures and communications, the transaction team will plan to provide information to a variety of stakeholders to minimize uncertainty and confusion over the course of the multi-month process.

The day of announcement of a signed (but not yet closed) transaction, designated management from the target and, upon prior approval the buyer, will want to clarify plans in conjunction with a press release by:

•Calls to key customer and supplier accounts

•Calls to union representatives

•Discussions with the leadership team of the target business concerning their retention, role in the organization going forward with the buyer, compensation, and location

•Discussions with potentially impacted personnel of the buyer, who may be worried they will be found redundant when the transaction is consummated, may also be prudent for the seller to undertake

•Calls to public officials (e.g. mayor where a significant facility is located)

On the day of announcement, properly sequenced messages to the employees at the target and the buyer, using intranet/internal email capability are undertaken. A cascade approach with senior managers being provided earlier notice and appropriate talking points, along with Q&As, is followed by a broad distribution of the press release internally among all employees.

•The communication to the employees of the target business should cover: will they be offered continued employment by the buyer; will their compensation (and other benefits) be unaffected; will they be required to relocate; what happens if they decline employment with the buyer; severance protection if they accept employment with the buyer yet leave at a future date

On the closing date a similar cascade of communications to employees is made, accompanied by a press release. In addition, it is prudent for the buyer to immediately distribute an organization plan for the target company identifying the leadership team and the reporting relationships of key associates. Avoiding confusion at the onset is crucial for a smooth transition of the business to the buyer.

Chapter 3

Divestiture Process

3.1 Preparation, Executive Summary

It is useful to consider three stages of work prior to contacting potential buyers. The strategic assessment activity builds trust with the Board of Directors and the senior management of the firm that the divestiture candidate makes sense when looked at from the perspective of the enterprise as a whole. The feasibility assessment results in an informed analysis of the likelihood of achieving the desired selling price. A realistic view of the value buyers will place on the divestiture candidate will help reduce anxiety that the divestiture process will create work and disruption yet be unlikely to bear fruit. The transaction preparation includes identification of internal team members and external advisors needed to execute the transaction and gains approval for their use from senior management. When internal team members are contacted to join the transaction team they can be assured their managers and the firm’s senior management have endorsed their participation and implicitly if not explicitly recognized they will be asked to do two jobs for a period of time.

The parameters of the business being sold are defined at this stage, which allows a robust discussion among the business management team and senior managers about facilities, personnel, and intellectual property and the trade-offs between value received from buyers and value to be retained by the company. By facilitating this often-difficult discussion, the internal M&A group will build trust with all the players. Stabilizing the management of the business being sold through appropriate incentives is also discussed at this stage.

Strategic Assessment: Allocate 4-6 weeks.

Ensure internal alignment that the business is non-core as a first step. This work can be done in partnership with the corporate strategy group and the operating unit charged with management of the business. Larger divestitures may come up for consideration as part of an on-going portfolio review process, inquiries from potential buyers, or Board level analysis requests. Among the questions asked are: is the business on trend with consumer needs and demographics and/or technology changes? Does the business have a sustainable competitive advantage versus competition in terms of quality, taste, packaging, cost structure, distribution/marketing or other dimensions? Does the business support economies of scale in sales, distribution or manufacturing? Will the intellectual property used in business, if it becomes available to competitors, pose a risk or have an adverse impact on other business units?

In CST’s work with clients to identify divestiture and acquisition opportunities I like to start with an overview of the category landscape. I look at forecasted overall category growth rates and operating margins that firms in the category typically realize. The sources for the forecast growth figures can come from Nielsen, IRI, Euromonitor, or market surveys performed by researchers at Mintel or similar firms. The operating margins estimates can be built from stock analyst estimates of companies and divisions of companies which are competing in the category. Filings (in the US) with the Securities and Exchange Commission for public companies’ stock and debt offerings are a great if time-consuming way to develop a view of margins. Over time, regular annual and quarterly filings, IPOs, filings associated with material acquisitions and divestitures, and fairness opinions will contain information relevant to operating margin estimates in a category. CST has put together branded operating margin estimates for +80 categories of foods and beverages in the US using this approach.

Against the industry landscape, CST compares the business unit or units of our clients on similar dimensions of growth and profitability: if the client’s business is sub-par in terms of growth or profitability CST digs in and assess the causes (e.g. market share loss) and potential for reinvigoration.

If the business unit does not believe it has credible means to achieve its desired level of growth and profitability CST recommends testing the alignment of senior executives before embarking on additional preparatory work. Establishing an agreed upon divestiture strategic template and review process, in advance of a specific divestiture, represents best practice.

The strategic divestiture template for non-material divestitures (defined here as less than 5% of revenues or profits) can be as short as one page, and as simple as a brief description covering:

•The business’ products, facilities, personnel and key intellectual property to be offered for sale

•Why the business is no longer of strategic interest

•Identification of common systems deleveraged upon sale

•Summary P&L and cash flow, including budget projections, of the divestiture target

Recommended Reading:

Porter, M., Competitive Strategy, The Free Press a division of Simon and Schuster, Inc.

Porter, M., On Competition, The Harvard Business School Publishing Company

Mankins M., Harding D., Weddigen, R.M., How the Best Divest, Harvard Business Review

Feasibility Assessment: Allocate 3-4 weeks.

After passing the strategic screen and securing senior management initial concurrence, the M&A team prepares, or assists the operating unit in the preparation of, an estimate of the minimum selling price which needs to be obtained to ensure shareholder value is obtained if the sale is completed. This involves a realistic estimate of the business’ future prospects. The forecast should take into account historical business performance and the challenges/probability of achieving both short-term budgets and longer term strategic plan targets. The impact of stranded overhead costs, as well as taxes payable on the sale, are taken into the calculation.

The resulting minimum selling price, or Keep Value DCF, is compared to how potential buyers will value the business. Prior transactions in the industry/category as well as the trading multiples of public companies (enterprise value divided by EBITDA) provide useful guideposts. More detailed analyses can be conducted by looking at specific buyers’ likely synergies and estimating how much they can pay and still achieve an acceptable return (whether NPV positive or expressed as an internal rate of return/IRR). For private equity buyers, the amount which can be paid and still yield an acceptable IRR will vary with lending conditions including debt availability (debt/EBITDA), minimum equity requirements, and the cost of debt (also known as a leveraged buy-out due to relatively high reliance on debt financing). The historical multiples a potential buyer has paid for a business in terms of EBITDA and revenues also informs the analysis. A comparison of Keep Value DCF and the likely valuation range of buyers in graphic form is called a football field format. The Keep Value DCF is often shown as a range as well to reflect a range of assumptions, from different terminal value calculations to different business growth rates with these factors delineated in the text accompanying the chart.

The figures in the chart are meant to be illustrative, and the relationships between the different valuation metrics will not hold across all businesses. However, some generally expected valuation ranges are indicated.

The value a seller needs to receive from a buyer is higher than the present value of its discounted future cash flows. The seller will pay a capital gains tax on sale proceeds and needs a premium to cover this tax outflow.

A buyer will (hopefully) have cost and revenue synergies it can realize with the target business. These synergies can enable the buyer to pay a value above the present value of the discounted cash flows which the seller might realize if it kept the business.

Leveraged buy-outs by private equity firms have two sources of value which can help this class of buyer cover some of the taxes payable by the seller in the form of a higher sale price. First, the capital used by private equity to finance an acquisition is largely sourced from relatively inexpensive debt. In contrast, the target business must produce returns which satisfy the return expectations of stockholders, which are higher than debt holders. In effect, private equity firms capture the spread in the cost of debt versus the cost of equity as value they can deliver to their investors. And share in part with the seller of a business. The second source of value is improved operation of the business with proven management deploying best practices in operations and G&A cost efficiency.

Comparable transactions in the same industry as the target company will often reflect a